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Defensive stocks for tough times.

October 3rd, 2008 · Greg Atkinson · No Comments

In bear markets we often hear a lot about so called defensive stocks, but what exactly are defensive stocks and are the traditional defensive stocks still a good option in this particular bear market?

A defensive stock should remain relatively stable in terms of price in times of market volatility. The reason for this is that defensive stocks are generally in sectors where demand for their goods and services hold up during economic downturns. For example we would generally expect utilities companies (such as gas and electricity) not be hit hard by a slump in the economy because people and business still need to use energy. Other areas that tend to hold up well in times of trouble are for example food, alcohol and telecoms. So in theory a company that owns a major chain of supermarkets should be okay during the current bear market as people still need to eat, but unfortunately it is not quite that simple.

Firstly before we start moving money into defensive stocks we have to understand that in this credit crisis triggered bear market, having a lot of debt is not seen as a good thing. Some companies can manage their debt even at relatively high levels but at the moment the market does not care, and if a company has a lot of debt their stock price has been hit hard. I cannot define what is meant by “a lot” because there is no value, it is just a perception that seems to get into people’s heads about certain companies. So even a company that should be seen a defensive has been hit if it appears it has a significant amount of debt, regardless of it’s ability to service their debt.

Secondly as I have mentioned my blog about 52 week high and low stock prices , even good reliable companies with solid cash flows have seen their stocks savaged and this is because there has been a broad exit of funds from the stock market. People have not just been selling a few stocks, but have been getting out of stocks entirely or have been forced to sell stocks to meet margin calls and therefore there has been selling pressure on every sector, defensive or not.

So this leads me to suggest that basically no sectors and few stocks in this current bear market could be termed truly defensive. Although I am bullish about stocks over the longer term, my suggestion to anyone who has cash would be to forget about looking for defensive stocks and just leave the money in the bank. I am also not a believer in adjusting a portfolio in troubled times to include more defensive stocks and especially not in this bear market, instead I use bear markets as a time to clean up my holdings, sell off the dud stocks that will probably never recover and top up my holdings in stocks I think will come back over the next couple of years.

However at the risk of being spectacularly wrong, I will highlight a few stocks I think are reasonable defensive plays if you want to go down that path. (remember I am not suggesting you buy these stocks, these are just my thoughts!)

Adcorp (AAU) – I have had stocks in this company (either directly or indirectly) for some years and to be honest I have yet to see a capital gain. Yet through all this credit crisis mess the share price has held up reasonably well, the dividend is being paid again and the company is debt free. However Adcorp is not likely to see so much revenue growth if the Australian economy heads into recession, as advertising tends to be one of those sectors hit fairly hard in times of economic downturn.

Melbourne IT (MLB) – Things really need to get bad before businesses cut back on services provided by ISP’s (Internet Service Providers) and so Melbourne IT should be able to weather the stock market storm better than others. I have only spent a little time looking at this company but it appears to pay a good dividend and be generally in good shape. I do not own shares in MLB but they are on my list of potential buys.

WOW (Woolworths) – It hard not to have this company on a list of possible defensive plays. I do not hold any shares in this company myself, but would be tempted to grab a few if the price came down to around $25. The company has a debt to equity ratio of around 50% but this should not be a major worry because of their strong cash flow position.

So my list is not very large and that reflects how uncertain the market outlook is at the moment. It is hard going finding true defensive stocks in this bear market but as I have mentioned before, we are probably in one of those periods where in a few years we will look back and wonder why we did not pick up more beaten down blue chip stocks.

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